Short-term factors driving the foreign exchange market
You will learn about the following concepts
- High-volatility economic indicators
- Shifts in importance of data
When it comes to short-term market movement, day traders closely observe economic data from the major economies, regardless of whether they are technicians or fundamentalists. Although many technicians say they don’t factor in economic indicators, nearly everyone takes them into consideration one way or another. Because important economic data are accompanied by high volatility and usually cause sudden and wide price spikes (climaxes), technicians who favour range trading, for example, tend to stay out of the market around the time of the release. In contrast, a technical breakout trader would favour exactly those market conditions, capitalising on the high volatility and price swings. At the same time, economic data are definitive for traders using automated systems with strategies based on data releases.
Logically, the economic figures that tend to affect currency pairs the most are those from the US. This is due to the greenback’s status as a reserve currency and the United States being the world’s largest economy, as well as a major importer and exporter of raw materials, finished products and services.
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According to the Triennial Central Bank Survey by the Bank for International Settlements, as of April 2013 the greenback stood on one side of 87% of all trades on the foreign exchange market. Thus, you can imagine the impact an indicator such as the US Nonfarm Payrolls has all over the world. If you want to learn more useful statistics regarding Forex, read our article “What does Forex stand for?”
Some US economic indicators have a huge impact on currency pairs, with sentiment shifts lasting for days, while other data may have little to no significance. In addition, over the years some releases have become more important for currency traders, especially when central banks’ monetary policies are tied to a certain economic activity gauge. We will get to that part a bit later.
Utmost importance
The most important economic indicator from the US remains the Nonfarm Payrolls report. The reason behind its huge market-moving ability is that it is indicative of the strength of the US labour market, and thus of the economy’s recovery pace. Moreover, US policymakers have tied the health of the country’s labour market to the Federal Reserve’s unprecedented Quantitative Easing programme, which was injecting $85 billion into the economy each month via bond purchases before it was trimmed in January 2014. Job creation has a positive relationship with consumer spending and retail sales and leads to tighter monetary policy. Conversely, an unhealthy labour market would hurt consumer sentiment and economic activity, introducing the need for lower interest rates, which depreciates the currency.
Nonfarm Payrolls were and remain the biggest market mover, followed by the FOMC’s interest rate decision, consumer inflation (Consumer Price Index), retail sales, producer inflation (Producer Price Index) and housing data, led by new home sales.
PMI readings
Also among the most important indicators are the ISM Manufacturing and Non-Manufacturing Reports on Business. The manufacturing data are more widely followed than the figures released by Markit Economics (the US Manufacturing PMI).
However, the non-manufacturing data have an even greater impact on daily price movement as the services sector accounts for almost 80% of the country’s GDP, compared with the industry sector’s 19% contribution and around 1% from agriculture. What is more interesting is that the non-manufacturing report has a more muted effect on the markets immediately after the release but causes a strong move on a daily basis. Both ISM reports contain a large number of underlying components, which require more time for traders to assess and to determine how they might influence the Federal Reserve’s decision at its next policy meeting. The ISM figures are also very closely observed for the employment component, which provides a preliminary insight into the labour market ahead of Nonfarm Payrolls and is therefore a leading indicator.
Some economic indicators have grown in significance in the last decade due to shifts in the US economy’s condition, while others’ importance has significantly receded. One of the strongest market movers in the 1990s was the US trade balance, while it has now fallen out of the top ten. Trade data may be of importance when a country is running a large trade deficit, but as economic conditions change, focus shifts to different data sets that are more indicative of its recovery. For example, the Federal Reserve tied the reduction of its monthly bond purchases to the US economy’s performance, and mainly to the health of the labour market. Even as it began gradually to trim its Quantitative Easing programme, policymakers vowed to keep interest rates at historically low levels until the unemployment rate reaches a sustainably low level. For the same reason, consumer sentiment indicators also affect the US dollar. They are seen as leading indicators for the direction of household spending, which makes up 70% of the country’s GDP.
A very interesting shift in significance has affected Gross Domestic Product. Although it was ranked as the fifth most significant market mover in the 1990s, it now has very little effect on the US dollar for several reasons. First, the figure is published quarterly, as opposed to the most important indicators’ monthly release. Moreover, the reading is based on data that are released monthly within those three months; investors therefore have enough accurate information ahead of the GDP publication, which is already priced in, and surprises are rare. Furthermore, because a GDP figure can be boosted by factors with different effects on the US dollar, it is often misinterpreted. Strong exports boost GDP and raise the dollar’s value as more people buy the greenback to pay for goods produced in the US. In contrast, GDP growth based on an inventory build-up, such as in Q3 2013, may be seen as negative for the dollar as it may be followed by stalling growth in subsequent quarters.